Connect to share and comment

Cyprus: Another fine mess

Analysis: As Cypriots swarm to their reopened banks, the EU's botched rescue of Cyprus underscores more euro zone risk.

Cyprus bank 2013 03 28Enlarge
Cypriots line up outside a Laiki bank branch in Cyprus' capital, Nicosia, on March 28, when banks opened after a 12-day lockdown. (Patrick Baz/AFP/Getty Images)

BRUSSELS, Belgium — Even by euro zone standards, the handling of Cyprus' banking crisis has been a monumental mess.

After a week of backtracking, blundering and last-minute brinkmanship, the deal stitched together between the Cypriot authorities and other euro zone governments in the small hours of Monday morning averted the imminent risk of a banking meltdown and ejection from the common currency union.

"Cyprus was a breath away from economic collapse," President Nicos Anastasiades told his people in the hours after the deal. "The agreement we reached is painful but the best we could secure under the circumstances."

Despite Anastasiades' assurances, the island state remains adrift in a sea of economic difficulties with potentially disastrous implications for the wider European economy.

Cypriot banks reopened Thursday after being closed for nearly two weeks. The government enacted tight controls on transactions to prevent a run on savings, decrees that are taped on bank branches' windows. They include a cap on withdrawals at 300 euros ($383) and severe limits on transfers out of the country. Credit and debit card holders can spend up to 5,000 euros (under $6,400) per month, and Cypriots may deposit checks into their accounts but not cash them.

The controls will be phased out in about a month, Foreign Minister Ioannis Kasoulides told reporters.

Savers with more than 100,000 euros ($127,800) in Cyprus' largest banks are facing losses estimated at up to half their deposits as the capital is converted into shares.

Economist Paul Krugman is predicting the crisis will see the Cypriot economy shrink 20 percent, as credit from the country's surviving banks dries up. The head of the country's biggest bank was fired on Wednesday.

All that is happening despite the bailout, which most observers see as a huge improvement on a plan EU finance ministers tried to impose on the country last week but which the Cypriot parliament rejected.

The current agreement will secure a $12.8 billion bailout for Cyprus from the European Union and International Monetary Fund. That should keep the economy afloat, preventing the collapse of the financial system and keeping the country in the euro zone.

As part of the deal, Cyprus will have to raise $7.4 billion from savers with more 100,000 euros in their accounts — many of them are wealthy Russians who had taken advantage of the island’s advantageous offshore conditions.

Cyprus's second largest bank, Laiki Bank, will be shut down and the Bank of Cyprus radically restructured.

GlobalPost analysis: Cyprus bailout plan hits Russian economic model

The previous agreement struck by EU finance ministers on March 16 would have hit all savers — those with less than 100,000 euros in their accounts would have faced a bank deposit levy of 6.7 percent, while those with bigger deposits would have to pay 9.9 percent.

That was widely denounced as going against the principle that the savings of ordinary citizens should be protected from banking crises. It triggered fears, not only of a run on banks in Cyprus, but that deposits across the euro zone could be at risk.

“The Cyprus bailout deal is a disaster," Sharon Bowles, chair of the European Parliament's Economic and Monetary Affairs Committee said of the first deal. "It robs smaller investors of the protection they were promised. If this were a bank, they would be in court for mis-selling."

Although the Cypriot parliament's rejection forced EU ministers into a rethink, many fear that first decision has significantly damaged confidence in the euro by showing that governments are prepared to go back on their commitment to protect small savers.

Even the new deal is making investors nervous about holding money on troubled southern European countries like Spain, Italy, Portugal and Greece, let alone Cyprus itself. A survey in Spain, showed 62 percent are worried their deposits may not be safe.

Such fears were not helped by comments by the new chairman of euro zone finance ministers, Dutch politician Jeroen Dijsselbloem, who suggested on Monday that the Cypriot deal could be a template for other countries in trouble. That sent markets tumbling and the Dutchman was forced to recant, stating, “Cyprus is a specific case with exceptional challenges."

Cyprus is one of the euro zone's smallest members, representing just 0.2 percent of the bloc's economy. It only joined the group five years ago and risked becoming the first nation to leave in the bloc’s 14-year existence. But the island's woes have revived fears about the future of the currency bloc after a period of relative calm when Europe seemed to be taking real steps to tackle its financial problems.

Germany and the other euro zone nations could have bailed out Cyprus without breaking into a sweat, some analysts say, but the government in Berlin was anxious to show voters that debt-ridden nations would have to shoulder more of the burden of their own rescue.

In particular, German Chancellor Angela Merkel was anxious that German taxpayers' money would not be bailing out the rich Russians who have parked their gains in Cyprus' offshore coffers.

However, as a result Europe's policymakers have again been shown to be divided and indecisive, reviving the air of permanent crisis hanging over the euro.

They may get away with it this time, given the size of the Cypriot economy, but much bigger risks lie ahead — most notably the political deadlock that’s holding back much-needed economic reforms in Italy.

Angry Cypriots are taking to the streets as the island braces for a prolonged recession.

Much of their wrath is directed at Merkel and other European leaders for the botched rescue. They also remember the decision back in October 2011, when investors in Greek banks were forced to take a "haircut" that wiped out more than half the value of their bonds. Banks in Greek-speaking Cyprus were among the hardest hit by that decision.

Cyprus may still have a life preserver, lacking other euro crisis victims. The eastern Mediterranean country of just over a million is believed to be sitting on vast natural gas resources — by some estimates they are worth about $400 billion and could be enough to supply 40 percent of the EU's needs.

http://www.globalpost.com/dispatch/news/regions/europe/130327/cyprus-bailout-EU-euro-zone